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5 ECONOMIC REVIEW(A Monthly Issue) June, 2012 Economics & Strategic Planning Department An Analysis on the Plunge in Hong Kong s GDP Growth and Prospects Wang Chun Xin, Senior Economist As the European debt crisis rages on, Hong Kong s economy had been widely expected to gradually slow down. However, the dramatic decline in Hong Kong s first-quarter GDP growth to 0.4%, 4.6 percentage points lower than the rate of growth for 2011, still came as a shock to many people. Has Hong Kong s economy bottomed, and what are its prospects? This paper aims to answer these popular questions. 1. Will external demand stabilize? The steep fall in external demand is without doubt the main reason for the plunge in GDP growth. Therefore, the future trajectory of Hong Kong s economy will largely depend on the prospects of stabilization in external demand. In the first quarter, Hong Kong s merchandize exports declined 1.5% compared with the same period last year. It was the first quarterly decline since the recovery in trade in 2010 and came in 18 percentage points lower than the average growth rate in the last two years. Adjusted for inflation, the decline widened to 5.7%, which was the worst performance since the fourth quarter of 2009 and over 20 percentage points lower than the average real growth rate in the past two years. As a result, net exports dragged down Q1 GDP growth by 4.7 percentage points, 1.4 percentage points greater than the average drag of 3.3% in the past two years. Since net exports accounted for over 90% of the drop in first quarter GDP growth rate, it is clearly the main culprit of the rapid deceleration of economic growth. The decline in merchandize exports will definitely impact service exports. For the time being, thanks to booming demand from mainland tourists, Hong Kong s travel service exports have continued to grow strongly at rates of over 15%. However, Hong Kong s overall service exports growth still declined to 9.1% from the average pace of 18.9% in the past two years. The inflation-adjusted real growth amounts to only 3.6%, considerably lower than the 10.7% average clip over the last two years. Net service exports contributes 1.1 percentage points to first quarter GDP growth, significantly smaller than the 3 percentagepoint average over the last two years. In other words, in the first quarter, the contribution of service exports to Hong Kong s economic growth weakened by more than 60% compared with the average of the past two years, lowering GDP growth by 1.9 percentage points. Overall, slackening external demand has had a major effect on Hong Kong s economic performance, with its contribution to real growth dropping precipitously from an average of -0.3 percentage points in the past two years to -3.7 percentage points. The resulting gap of 3.4 percentage points is greater than half of the difference between Q1 GDP growth and that of the past two years (6.1 percentage points). Had Hong Kong s domestic demand not remained strong to partly offset the impact of falling external demand, Hong Kong s economy would have shrunk in the first quarter. More importantly, external demand will be the bellwether for the Hong Kong economy s future trajectory. Should external demand pick up, Hong Kong s economy would probably rebound. Judging from current circumstances, the answer seems to be positive due to the following factors. First, global trade will likely grow in 2012, which suggests that Hong Kong s external demand still has The viewpoints in the Economic Review do not necessarily represent the opinions of the Bank of China (Hong Kong) Limited.

6 room to grow. According to the WTO s latest forecast, global trade in 2012 will increase 3.7%, lower than the previous projection of 5.8% by more than 2 percentage points due to the effect of the European debt crisis on trade. (Over the past 20 years, global trade expanded at an average annual rate of 6.7%, 3.4 percentage points faster than GDP growth. Therefore, under normal circumstances, global trade this year should grow between 6.5% and 7%.) Nonetheless, the outlook remains markedly better than during the financial crisis in 2009, when global trade plunged 22.6%. Past experience shows that Hong Kong s external demand is fairly in sync with global trade. For instance, in the past five years, global merchandize exports increased at an average annual rate of 5.7%, while Hong Kong s merchandize exports increased at a clip of 6.3%, or 1.1 times as fast as the global rate. Any positive growth in global trade this year should provide support for the recovery of Hong Kong s merchandize and service exports. In April, Hong Kong s total exports increased 5.6%, which, notwithstanding the relatively low base as a result of the Japanese earthquake last year, suggests that Hong Kong s external demand could still benefit from the tepid growth in global trade. Second, mainland China s economy will probably rebound and help fuel a gradual recovery in Hong Kong s external demand. As a major trading partner of Hong Kong, the mainland has always been a major stimulant of growth of Hong Kong s external demand. Over the past 10 years, the increase in Hong Kong s exports to the mainland accounts for more than half of the growth in Hong Kong s overall exports. Moreover, exports to the mainland as a percentage of total exports increased from 36.9% in 2001 to 52.4% in However, in the first quarter, due to the mainland s excessive slowdown, export demand weakened rapidly. In addition, the European debt crisis has hit the mainland s exports hard, resulting in a 2.2% decline in Hong Kong s exports to the mainland. This decline, while not as great as that of Hong Kong s exports to the EU (4.2%), is nonetheless greater than the drop in total exports. As exports to the mainland represent a high percentage of total exports, the decline in exports destined for the mainland accounted for nearly 80% of the decline in Hong Kong s total exports. In order to ensure an economic soft landing, Premier Wen recently stated that ''Stabilizing growth should be a more prominent priority, and appropriate preemptive measures as well as fine-tuning should be carried out in a timely manner.'' The implication is that the government will further ease fiscal and monetary policies, stimulate domestic demand, increase infrastructure investment, and support the export sector. Thanks to the stimulus generated by the compounding effects of fiscal and monetary policies, the mainland s demand for exports will likely pick up, and Hong Kong s exports to the mainland will return to growth. However, it should be noted that the European debt crisis is still evolving, and the effects of a shrinking European economy on Hong Kong s export demand are emerging. In April, growth in the mainland s total imports and exports slowed further, coming in at 2.7% and even lower than the 6% pace recorded in the first quarter. Furthermore, as the mainland s economic stimulus policies will take time to have their desired impact, Hong Kong s merchandize and service exports will not improve dramatically in the short term. Recovery will probably take place in the second half of the year, and merchandize exports for the whole tear will grow about 3.5%. Net exports in goods and services are still expected to reduce GDP growth by 1.2%, yet it would represent an improvement of 2.5 percentage points compared with the first quarter. 2. Will consumption remain robust? With anemic external demand, domestic demand has become a major factor of Hong Kong s economic growth. Consumption is undoubtedly the most important component. Last year, private consumption surged 8.5%, breaking the record in 2007 to register the strongest growth rate in 10 years. Personal consumption growth in the first quarter slowed to 5.6% but remains above the 10-year average of 4.8%. Meanwhile, consumption s contribution to GDP growth, at 3.5 percentage points, is 1.1 percentage points higher than the average level of the past 10 years. Clearly, personal consumption has remained strong and supported Hong Kong s economic growth when external demand was extremely weak. The boom in personal consumption is partly due to the rapid growth in income. Last year, Hong Kong s 2

7 per capita GDP increased 8.2%, the highest growth rate in the past few years. Moreover, since the minimum wage came into effect in May of last year, grassroots ''salary earners'' have see their paychecks rise. Wealth effect has also played a role in the consumption boom. In particular, since the housing market bottomed in the financial crisis, it has rebounded over 80%, smashing records along the way. It is expected that these two positive factors will continue to lend support to growth in consumption expenditure. The recent rise in consumer confidence, in particular, will help private consumption propel economic growth this year. According to Neilson, the market research firm, the consumer confidence index in Hong Kong rebounded to 103 in the first quarter after two quarters of decline. Although the number is below the 107 points recorded in the same period last year, it rose 4 points from the previous quarter, confirming that domestic consumer confidence is still elevated. Nevertheless, it should be noted that the gloomy global economy will definitely impact Hong Kong s economic performance. Income expectation of Hong Kong residents could drop, negatively affecting consumer confidence. The Neilson report also pointed out that, due to the volatile global economy, consumers bank deposits as a percentage of liquid assets shot up to 80% from 59% in Consumers are thus expected to become more restrained and prudent in their spending. The slowing private consumption growth in the past six months is partly due to the worsening global economy amid the European debt crisis. The IMF projected that the global economy would grow 3.4% this year, lower than the 4% growth of last year and around 5% growth in normal times. Hong Kong s consumer confidence will likely fluctuate too, hindering further expansion in personal consumption expenditure. In the meantime, the impact of rising unemployment rates on consumption cannot be ignored. Hong Kong s unemployment rate is currently at a low of 3.3%, but history has showed that Hong Kong s unemployment rate is highly correlated with GDP growth. If GDP growth keeps coming in below 4%, the relatively lagging unemployment rate will trend upwards. In the first quarter of this year, Hong Kong s economy was already at the edge of recession, while second-quarter performance is also expected to be underwhelming. Therefore, the unemployment rate will inevitably rise, probably reaching 3.8% at year end. Personal consumption expenditure is likely to gradually slow down, growing 5.0% for the year. Even though the projected growth rate is 3.5 percentage points lower than that of last year, personal consumption expenditure growth is likely to be relatively stable. 3. Will investment stabilize growth? In the past ten years, investment contributed 0.64 percentage points on average to economic growth, accounting for about 15% of the driving force. In comparison, in the first quarter of this year, investment only contributed 0.43 percentage points to GDP growth. Domestic fixed capital formation and inventory, two of the main components of investment, moved in opposite directions. And the sizeable divergence affected investment growth. Domestic fixed capital formation has been a major driving force of the recent economic recovery in Hong Kong, contributing 1.5 percentage points to GDP growth in both 2010 and 2011 and accounting for 21% and 30% of growth, respectively. In the first quarter of this year, fixed capital formation grew at a real rate of 12.2% and contributed 2.3 percentage points to GDP growth. There are a couple of reasons for such strong growth. First, the government s ten major infrastructure projects have been under way. In the first quarter, public sector building and construction expenditure increased at a real rate of 17.2%, much higher than the 2% average rate in the past 10 years. Second, in order to improve goods and services, the private sector substantially increase investments in machines, equipment, and software, which jumped 23.1%, considerably faster than the growth rates of 6.4 and 13.7% in the previous two years, respectively. Currently, the government s ten major infrastructure projects are entering a boom phase, and expenditures are set to increase and grow relatively fast in the near future. The adjustments and improvements in real estate policies are leading to faster construction in both public and private housing. Meanwhile, the Kowloon East development initiative will enlarge the construction scale of commercial buildings. The 3

8 private sector will also increase investments in machines, equipment, and software. However, due to the slowing global economy, such expenditures will become rather volatile in the future, and growth will likely decelerate. In general, the growth in domestic fixed investment will continue, contributing about 1.8 percentage points to GDP growth. It would be lower than the level seen in the first quarter yet significantly greater than the average in the past 5 years by 0.8 percentage points. Inventory de-stocking is one of the major determinants of Hong Kong s investment growth and overall economic performance, in the first quarter. As the European debt crisis exerts downward pressure on the global economy, the pace of inventory de-stocking in Hong Kong has picked up since last year, shaving 1.3 percentage points off GDP growth. In the first quarter of this year, the drag widened to 1.9 percentage points. In the future, de-stocking will continue but at a slower rate, reducing GDP growth by 1.4 percentage points and becoming another negative factor in addition to weak external demand. In light of the extreme divergence of fixed investment and inventory, two traditional driving forces of investment, the investment growth curve of this year will be rather volatile. Changes in de-stocking, in particular, will directly impact the pace of economic growth. For 2012, total investments will likely contribute 0.4 percentage points to GDP growth, slightly higher than the first quarter but lower than the average level of the past ten years. 4. Latest projections of economic growth for 2012 To summarize, whether Hong Kong s economy would rebound in the future depends on the possibility of an upturn of external demand and stable domestic demand. Under the negative influence of the European debt crisis, growth of global trade will be weaker than normal, and Hong Kong s external demand will be hard pressed to get out of the current slump. As a result, it would be very difficult for the Hong Kong economy to achieve trend growth. Nevertheless, the problem facing external demand right now is mainly a structural one, as opposed to worldwide gloom. Some parts of the globe are outperforming the regions that are going through a rough patch. The U.S. economy is stabilizing, while mainland China will adopt stronger measures to boost domestic consumption. As for other emerging economies, there is plenty of room for stimulus policies. Therefore, the global economy and trade will not experience a wholesale recession as seen in This year, Hong Kong s merchandize trade will likely grow at a moderate rate of 3.5%, with corresponding growth in services trade. GDP growth will thus receive a boost. Hong Kong s overall domestic demand will remain stable. In particular, consumption demand will continue to be a pillar of economic growth. However, domestic investment might undergo some new changes. It should be noted that in the past, Hong Kong s domestic demand has been very susceptible to external demand. For instance, during the three external crises in 1998, 2001, and 2009, Hong Kong s merchandize exports shrank 6.6% on average, while personal consumption expenditure and domestic fixed capital formation declined 1.6% and 3.2% on average, respectively. As it stands now, external demand is weakening, but growth in domestic demand remains relatively strong. Such combination of weak external and robust domestic demand is not usual in Hong Kong s economic development history. If this phenomenon becomes a trend, it would be beneficial for the stable development of the Hong Kong economy. Overall, if the European debt crisis should not spiral out of control, technically speaking, Hong Kong s weaker-than-expected economic performance in the first quarter could turn out to be the bottom of the current phase of economic adjustment triggered by the European debt crisis. The second quarter may witness further consolidation, and a rebound would probably take place in the second half of the year. In other words, growth in 2012 will gradually trend upwards. Annual GDP growth may come in around 2.5%, slightly lower than the 3.5% growth forecast made at the end of last year. Should the European debt crisis escalate and result in the disintegration of the Euro zone, greater economic and financial crises would follow, dealing a huge blow to the highly open Hong Kong economy. 4

9 (Key Economic Indicators). GDP /Q4 2012/Q1 ( ) GDP ($100 Million) 17,376 18,250 4,826 4,424 (%) Change (%) External Trade /4 2012/1-4 ( ) Total trade ($100 Million) Domestic exports Re-exports 29,615 32,716 2,615 10,295 Total exports 30,310 33,373 2,663 10,472 Total Imports 33,648 37,646 3,091 11,885 Trade balance 3,338 4, ,413 (%) YOY Growth (%) Domestic exports Re-exports Total exports Imports Consumer Price (%) Change in Composite CPI (%) Sale & Purchase of Building Units ( ) No. of agreements 162, ,814 10,728 34,949 (%) Change (%) Employment / /2-4 ( ) Unemployed (ten thousands) (%) Unemployment rate (%) (%) Underemployment rate (%) Retail Market /4 2012/1-4 (%) Change in value of total sales (%) (%) Change in volume of total sales (%) Visitors ( ) arrivals (ten thousands) 3,603 4, ,506 (%) Change (%) Financial Market /2 2012/3 (US$100 = HK$) H.K. Dollar Exchange Rate (US$100 = HK$) (%) change in Money Supply (%) M M M (%) Change in deposits (%) Total deposits In HK$ In foreign currency (%) Change in loans & advances (%) Total loans & advances use in HK use outside HK Trade financing (%) Best lending rate (%) Hang Seng index 23,035 18,434 21,680 20,556 6

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